I should probably get this out of the way early – I have absolutely no idea whether we’re in a stock market bubble. I think predicting stock market bubbles is really easy to do – in hindsight. They’re not so easy to predict beforehand. There are, however, legitimate arguments to be made on both sides of the argument.
On the pro-bubble side we have markets chugging to new record highs, even though underlying economic numbers are tepid at best. Additionally, we have all sorts of economic stimulus from not only the Fed but from other central banks around the world, including from Asia and Europe. All this stimulus is essentially the central banks of the world screaming at investors to get out of bonds and get into equities. This is all fine and good, until the taps get turned off, and recent tapering discussion from the Fed indicates that this may happen sooner rather than later.
Additionally, pro-bubble folks can look at the Shiller P/E ratio, which looks at inflation adjusted earnings over the past 10 years for the S&P 500, and see that it’s at over 25, easily on the upper side of its range over the years.
Meanwhile, we have the other side of the bubble argument, which argues that, while perhaps stocks are a little overvalued, they’ve got a long way to go. The Shiller P/E ratio peaked at over 44x during the boom of 1999, which means we still have a long way to go until there’s any comparison to 1999. It’s even sitting below the peak hit during 2007, and there was a giant catalyst that existed during that peak.
Also, it seems like everywhere I go I’m hearing people talk about a stock market bubble. The Wall Street Journal talked about it last week, and others have joined the fray, starting to get visibly nervous about the levels of the market. This itself can be taken as a contrarian indicator, meaning that if everyone is talking about a stock market bubble, this makes it more unlikely that there actually is a bubble.
And finally, the creator of the Shiller P/E ratio, Robert Shiller himself, weighed in inside that WSJ article, saying “The market is somewhat high, but it’s not a time where I would be writing ‘Rational Exuberance.'” Shiller, of course, correctly predicted the housing bubble, so perhaps he knows a thing or two about bubbles.
If investors don’t invest in stocks, where can they put their money and still see a decent return? Bonds are risky because of the threat of increasing interest rates (especially long bonds), real estate prices have already had nice recoveries across the nation, and precious metals have their own set of problems. Stocks have become the default choice at this point, which is exactly what central bankers want.
What Should You Do?
Personally, I think we are due for a correction. As I type this, the S&P 500 (SPY) is up 26.9% year to date, and that’s not even including dividends. That’s a terrific year, and the best since 2009. Markets haven’t had a 15% correction since the middle of 2011. This market has performed too well lately for me not to get nervous.
And yet, I’m trying my best to ignore it.
I look at each of my holdings individually, and ask myself “would I continue to buy this stock at this level?” If the answer is yes, I either hold or consider buying more. If the answer is no, I look at selling it. It’s that simple.
The underlying market should still slightly influence decisions, but it doesn’t play a huge role. If I like a stock and I think it’s undervalued, I’m going to buy it. And if I’m sitting on a good profit on something and I think it’s a little overextended, I’m going to sell it. I make my decision on individual equities, not the overall market.
These days though, I’m selling far more than what I’m buying. The market, at least from my perspective, seems pretty high. I just can’t find the bargains I used to. I see that earnings growth is being driven more by cost cutting and low borrowing costs, and less by actual growth, especially when I look at large cap names. I see dividend growth names that have been bid up simply because no good alternative exists, like when I wrote about McDonald’s (MCD).
But while I think the market is a bit frothy, I’m still invested in it. I’m still long a bunch of names. And while I’m selling more than I’m buying these days, I’m still buying the odd name and holding quite a few more. The key is to stay invested.
If you can still find stocks in this market that you’d like to own, go ahead and buy them. Worry more about the valuations of the stocks in your portfolio and worry less about the overall market. People are really bad at predicting the overall market anyway. It’s best not to even try.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More…)
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